How safe is your 401k account with your employer?
This instrument was created for working people like you and me, thinking that the market would present a better gain after 30 or 40 years than ordinary “safe” investments, such as bonds and CDs. It’s still the best strategy, even better than the old pension plans which, at times, were swallowed up by bankrupt companies. You must remember that 401k’s are safe even if the company that handles them goes broke, as in the case of Enron.
There is a federal law called the Employee Retirement Income Security Act (ERISA) that protects our 401k savings and other self-directed pension plans from financial loss and damages due to problems attributed to the trustee of the retirement plan. The law establishes the rules which retirement plan trustees need to abide by. So if a person or fiduciary commits fraud or goes bankrupt, your funds will be recoverable.
How safe is your 401k account’s underlying securities?
Recently, we’ve seen a spate of financial companies going under or struggling in this tumultuous financial period. But you shouldn’t worry: your 401k’s are safe at their current value if the finance company goes down. If your retirement plan is invested with a financial organization that goes kaput, then the Securities Investor Protection Corporation or SIPC will step in to ensure that you recover your funds at their current value. Your money is not mixed with the troubled company’s stock or funds and is held separately. Gerri Willis in her column Top Tips says “Your money is held in trust for you on your behalf. No one can access it. Not even bankruptcy courts.”
Photo by Cariboub
How safe is your 401k account in your own hands?
But of course, safety only goes so far — although your retirement funds are safe from the troublesome things your company, employer, plan manager, brokerage or fund company may possibly do, they are not safe from your own actions. If you decide to invest aggressively and your 401k tanks, then you’re on your own.
Keep in mind, though, that your 401k’s poor showing is most likely a temporary thing, unless you’re overexposed to high-risk asset classes. This article suggests some great ideas to keep your money safe from yourself 😉 :
- Read the fine print of your company’s 401k plan.
- Know what you’re investing in.
- Diversify. A good rule of thumb is to invest no more than 10% of your overall retirement funds in your company stock. Note that your employer may want their matching contributions to be in their own company’s stock, so take this into consideration in your investment plan. Here’s proof that stock market diversification works.
- Evaluate your investment portfolio regularly.
- Reallocate or rebalance your investment portfolio over time.
You as an employee select how you want that money distributed. If you have more bonds than stocks, you may be better off in these trying times. But remember that your 401k and other retirement accounts are supposed to cover your golden years and need to build over the long term, so your portfolio will need equities in order to grow.
The only people who are hurt right now are those who were thinking of retiring. Whatever your situation may be, do not touch these 401k accounts — unless you’re a retiree, in which case you may not have a choice. If you’ve got a long time horizon, you can only hurt yourself by selling low, unless of course you have absolutely no choice (say, if you have an emergency). Before that last resort, consider instead, the option of taking a loan against your account very carefully. There are drawbacks to this — such as missing out on tax-free compounding — but borrowing from your 401k may be a better option than pulling your money out completely; it will be much cheaper since no penalty will be exercised, just as long as you pay the money back with interest within five years.
The trouble with 401ks.
All this information is dry and unappetizing, yet millions of Americans depend on their 401k for their survival once they retire (who knows what will happen to Social Security 10 to 20 years from now). Since the Dow Jones has lost 36% of its value this year, thousands if not millions of potential retirees are wondering how to survive till they hit 65.
Most of them apparently weighted their plan with stocks, rather than with safe investments like bonds. So no surprise that there is a movement afoot to change the philosophy of 401k’s, once seen as the golden parachute for retirees. After all, how great is a 401k that isn’t available to you when you retire because it’s collapsed in value just when you need it most? Or because you raided it during your last emergency?
The question here, says the Washington Post Nancy Trejos, is whether we should continue to recommend 401ks as replacements for pensions. And to think that some crazy Congress heads want to hitch Social Security to the stock market.
How much protection should we get?
For many who are not able to manage their investments well, it really has amounted to a lottery. If the market does fine when we retire, we won’t have worries — a rising tide lifts all boats, remember? But if conditions are catastrophic as they are now, older people are taking a direct hit. So maybe we should stop thinking that the capitalistic strategy is good for most people, since the truth is, we can’t all protect everyone from themselves. In this case, could a dose of socialism (uughh) be in order?
This post is brought to you jointly by SVB and Jacques Sprenger.
Copyright © 2008 The Digerati Life. All Rights Reserved.
{ 11 comments… read them below or add one }
401(k)s remain a great tool to aid your financial future. The market will go up and down and paying attention to asset allocation is important especially as one nears retirement. But the biggest problem people face for their retirements today is not the decline in their appropriate retirement savings but their failure to save what is required in the first place. People need to add to their 401(k) not be scared of them. And they need to learn how to manage those assets throughout the rest of their life.
Our 401K is depleted. We will just leave it for now and wait for the market to turn. We thought we were doing everything right but c’est la vie!
I disagree with the assessment that only folks retiring or near to retirement are most hurt by the current downturn and its affect on our 401k balances.
This can hurt anyone who might need to access their funds soon – either to split in a divorce proceeding, roll out for living expenses (not a good idea but still sometimes necessary), or who have left one job and have a narrow timeframe in which to do something with their 401k.
Reallocate or rebalance your investment portfolio over time.
Although long term employment is not “the norm” anymore for a lot of people, some people do stay with the same company and the same 401k plan for a number of years. As a result, some people feel “stuck” – once it is in the 401k you can’t do anything else. You set your allocations and just have to grit your teeth and ride it out.
And if it’s all down, it may feel as if there are no safe choices.
But if you read your documents carefully, it may turn out (as some of us have found out too late) that you are allowed to withdraw some money with no penalty to roll into another investment for retirement. Without waiting for an event such as a job change.
Additionally, while you cannot allocate your deposits straight to a money market account, a number of funds do let you “cash out” of one investment into a money market account. (Note that some funds have a penalty for holding shares of the fund for less than X days.)
While today might not be the best day to dump everything that’s down %40 YOY and roll it into your 401k’s MM fund paying 2%, it’s good to know that if you feel we hit another bubble in a decade or so from now, you can.
Pretty good summary. A couple of things I’d like to add about “safe” options.
a. Most 401K offer something called “stable value”. This is usually the safest option, although you should still read the details to see where this fund invests the money in this fund.
b. “Most of them apparently weighted their plan with stocks, rather than with safe investments like bonds.”
When one thinks about bonds one need to keep in mind the bond funds that our 401K offer aren’t the same as individual bonds. Bond funds can go up or down.
When you buy an individual bond, you buy a fixed income investment that pays you a specific fixed interest and “promises” to return you your principal when due – i.e. on the date when the bond is matures. Different individual bonds carry different risk. Government bonds are safer than CDs as they are guaranteed by the full tax power of the US government. Among other bonds – corporate and municipal you have to check the rating (AAA is the safest; municipal are normally safer than corporate) and the issuer (how healthy you think the company is) to see how safe or risky the investment is.
While bonds come with a promise to repay you the principal at the time of maturity, the value of the bond between now and maturity can fluctuate. For example, when interest rates go down, the bond values normally go up; when the interest rates go up, the value of bonds go down. There are other cases – like during this credit crisis the values of bonds on the secondary market dropped. But if the company whose bond you have didn’t go bankrupt, you can still collect your interest and you will still get your full principal at maturity date.
Bond funds are different. Bond funds are NOT fixed income investments. They have a number of bonds each with different maturity date. When you buy into bond funds, the fund buys bonds for you at the secondary bond market at current values. When you sell your bond funds, you sell bonds at the secondary market. If the value of bonds dropped, so did the value of your investment. If at some point in future we’ll have higher interest rates, all bonds will cost less. This loss may in part be compensated by higher interest paid on new bonds your fund will buy when some of the old bonds mature, but you may have to wait to recoup your losses.
So it is a mistake to think that the money you invested in a bond fund are safe. The only exception is if the bond invests only in I and EE government bonds — these bonds aren’t sold on secondary market, so their value doesn’t fluctuate.
Great writing! You might really like this site too. It gives a top-down on 401ks.
http://www.facebook.com/pages/Diane-Garnick-Fan-Site/30099979536?ref=ts
From above: “the only people who are hurt right now are those who were thinking of retiring”
If you look at some of the long term graphs in the average medium risk 401k you can see broad fluctuations, and some extreme fluctuations and corrections in the high risk portfolios.
In the end, if you have another 20 years before retiring, just close your eyes stay in for the ride.
We’ve lost over 45,000 since the downturn is September, but what do you do?
Brentos
Up or down, the only people that need to worry are the people who are on the verge of retirement. My wife and I just lost $45,000 in the last few months…..we’re only in our mid 40s in age though.
I realize some people are simply not cut out for freedom, personal responsibility, or thinking and need socialism to survive. I am all for that as long as they aren’t taking from to me to support them and as long as I don’t have participate. I like the feeling of being the one in charge and not having to depend on my *benevolent* government for anything.
I leave everyone else and their money alone I only ask for the same courtesy.
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While running for President, Obama proposed to temporarily remove the 10% penalty for hardship withdraws from IRAs and 401(k)s. You would be able to withdraw up to 15% of your plan or $10,000. However, don’t forget that you will still have to pay income taxes on the withdraw. They will automatically withhold 25%.
“After all, how great is a 401k that isn’t available to you when you retire because it’s collapsed in value just when you need it most? Or because you raided it during your last emergency? ”
Probably even MORE true today than when you originally posted it… sadly.